A Key Definition in the Margin-Tax Scheme Would Have Catastrophic Impact

Much ado has been made, and will continue to be made, about what is the most important question on Nevada’s 2014 ballot. But one critical aspect of the state teacher union’s proposal to enact a business margin tax has gone virtually unnoticed: the definition of an “affiliated group.”

For the non-accountant, this might sound like a tedious and technical detail, but it could wind up as the most significant aspect of the proposal if the tax becomes law.

As with many business taxes, the margin tax would require business owners who have organized their operations under multiple legal entities to consolidate the finances of each entity onto a single tax filing. This “affiliated group” of firms is then treated as a single entity for tax purposes. For large corporations with multiple subsidiaries — MGM Resorts, for example — this is normally a straightforward operation that causes few problems.

The way that teacher union operatives drafted their proposed margin tax, however, is different. And it would wreak havoc for owners of both small and large businesses. The problem is how they’ve defined an “affiliated group.”

Union representatives have said their proposal was modeled after the Texas margin tax. In Texas, firms can be considered an “affiliated group” if at least 80 percent of the ownership of each firm is held by the same individual or group of individuals.

For Nevada, however, the union defined an affiliated group as “a group of two or more business entities, each of which is controlled by one or more common owners or by one or more of the members of the group.”

Under this changed definition, firms with only minority ownership in common would be considered an “affiliated group” and forced to file taxes jointly — an administrative nightmare for taxpayers and state tax collectors alike.

The only possibly mitigating language is the requirement that the entities are “controlled by” common owners. But here’s how the union proposal defines a controlling interest:

‘Controlled by’ means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a business entity, whether through the ownership of voting securities, by contract or otherwise.

Consider that definition carefully.

It appears to include many possibilities beyond the traditional concept of an “affiliated group.” Say a consulting firm that helps businesses organize their operations more efficiently contracts with multiple firms in Nevada and is compensated through performance-based stock options, as is typical for management consultants. The consultants, then, will have exercised at least an indirect power over “direction of the management and policies” for each of the businesses with which they contracted.

The stocks gained may only confer minor ownership stakes to the consultants in any of those businesses, but their contracts would legally unite each of their clients into an “affiliated group.” Each firm, then, would be forced to commingle their financial information and file a joint tax return — even if the firms are direct competitors!

Worse, the margin tax proposal would hold each of these firms “jointly and severally liable for the taxes of the combined group.” Theoretically, a firm could be forced into paying the taxes of its competitors — simply because both firms hired a common consultant.

In addition, the union’s definition of “controlled by” appears to regard an owner of a single share of stock as someone exercising a controlling interest. Indeed, an owner of a single share of stock who appears at quarterly stockowner meetings to address board members in an attempt to influence company direction would certainly be exerting an “indirect” power over the “direction of the management and policies of a business … through the ownership of voting securities.”

Consider an individual who buys one share of stock each in Caesar’s Entertainment, Las Vegas Sands, MGM Resorts and Wynn Resorts. If he or she attends at least one stockholder meeting for each corporation over the course of a tax year, attempting to influence the direction of each firm—at least “indirectly”—then all those mega-firms could be compelled to commingle their financial reporting and file joint margin tax returns.

While much would depend on how the state tax department writes regulations to implement the margin tax, the statutory language within the proposal itself is unambiguous.

The potential impact on business formation and investment in Nevada would be catastrophic. Once business people learn that Nevada’s margin tax could force them to pay competitors’ tax bills or to give competitors confidential and sensitive financial information, capital will flee Nevada in a panic.

We’ve only begun to explore the problems that this provision in the margin-tax ballot measure could create for the Silver State.